Currency Wars and your global bond portfolio

We have written about the “race to the bottom” with respect to global currencies. Basically, the developed world has a large overhang of debt that would be easier to pay with a devalued currency. The opposite is true with respect to many developing nations as their export sectors are reasonably fragile in a slowing global economy. They need to keep their currencies from appreciating too much in order to defend their exports.

Here are a few bullet points taken from a Bloomberg article to consider as you contemplate a placement in an ETF or mutual fund that invests heavily in the debt of foreign countries and their currency.

In China, authorities lowered the yuan reference rate to the weakest since November, which according to Citigroup Inc. will create “headwinds” for other Asian currencies.

“Policy makers will become more aggressive,” said Bhanu Baweja, a London-based strategist at UBS. “The currency strengthening is in contrast with the state of the economy. That argues for much weaker foreign-exchange rates.”

“We have a growth problem in the global economy,” Michael Ganske, the head of emerging-market research at Commerzbank AG in London, said in a phone interview. “Emerging-market central banks can’t let their currencies appreciate on the back of portfolio flows to the point it kills exports.”

All except four of 25 emerging-market currencies tracked by Bloomberg have weakened over the past 12 months. Brazil’s real lost 20 percent against the dollar in that period as the Hungarian forint fell 15 percent.

We recommend that you thoroughly examine your bond portfolio holdings as it relates to foreign debt. Divide the analysis among the three segments of risk and reward.

Interest rate-To combat a slowing global economy central banks generally have continued to lower their interest rates. While pockets of value persist, it is imperative to dissect your holdings to determine if the interest rate risk is properly aligned to take advantage of opportunities on various yield curves while guarding against unexpected shocks to interest rates.

Credit-If the world experiences continued slow growth, the potential for upgrades is suspect. Differentiate the potential among sovereign and corporate debt globally as they possess different risk reward characteristics.

Currency-This is has been the most volatile portion of risk lately and warrants close examination. It makes sense to be more specific in this area as opposed to holding a broad basket of non-dollar Emerging Market currencies.

While we believe bond and currency diversification continues to hold benefits at an absolute level and at the risk adjusted returns level, it crucial to examine your exposures to help mitigate unwanted and unrewarded currency risk in this “currency war”.